Bone Falloff not working?
I too am curious about the proper use of bone envelope in Blender too. The falloff appears to not be functioning correctly. This may be a bug. As you say it used to work, so something may have changed that stopped the falloff from working as desired.
I just double checked and what we are calling falloff is called 'distance'. I don't know if this name changed. I submit a bug report and see what happens.

Update: I have submitted a bug report and referenced this post, provided Blender files I used to test this too. It is definitely a bug, as the blender manual states the following: "The outside area, materialized by the lighter part around the bone, and controlled by the Distance setting. Inside this zone, the geometry is less and less affected by the bone as it goes away by following a quadratic decay." The quadratic decay appears to be what has failed.
https://www.blender.org/manual/rigging/armatures/skinning/obdata.html#bone-deform-options

Bug report: https://developer.blender.org/T50392